Customer Location Impacts State and Local Tax Compliance Requirements for Businesses
Many of the top state and local tax considerations for this year are the same as last year but there are a few new twists, largely due to the COVID-19 pandemic. As 2020 comes to a close and 2021 begins, one of the key determinants of state and local tax compliance requirements to consider is not so much where a business is located but rather where the business’ customers are located. You will note this is a recurring theme. The following summarizes the top state and local considerations for 2020/2021.
Wayfair Decision Tax Issues
The U.S. Supreme Court’s decision in South Dakota v. Wayfair has had obvious and profound implications for sales and use taxes. While not the main focus, the decision may also have substantial implications for income taxes.
Wayfair Sales Tax
The Wayfair decision by the U.S. Supreme Court rocked the sales tax world in June 2018. Wayfair continues to be the biggest state tax issue for businesses. Under the Wayfair decision, a business does not need to have physical presence in a state to be subject to sales/use tax collection requirements. ALL states, with the exception of Florida and Missouri, that have state level sales tax have adopted economic nexus thresholds. If your business is selling taxable goods and services to customers in states other than Virginia, you may have a tax collection requirement if the sales to customers in those states reach the states’ thresholds (typically, but not always $100,000 in sales or 200 separate transactions). It is important to note that the economic nexus thresholds do not apply if a business has a physical presence in a state. Key issues to consider with economic nexus are: (1) the volume of sales to customers in the states, (2) the taxability of your products/services) in the states, and (3) the states’ specific economic nexus thresholds.
Wholesalers are not immune from possible Wayfair repercussions – they need to document the exempt nature of their sales with properly completed exemption certificates, regardless of the location of their customers, as without exemption certificates a state may assess taxes, interest and penalties on their sales.
Wayfair Income Tax Issues
More states are adopting economic nexus for income/franchise taxes (meaning sales in the state may create a tax filing and payment requirement). While there is federal law that prohibits states from imposing income taxes on businesses that are only soliciting sales of a tangible product in the state, this does not apply to services or situations where the businesses go beyond mere solicitation. States may still require the filing of tax returns even if the federal law protections apply. Further, the federal protections do not apply to franchise taxes. Pennsylvania adopted an income tax economic nexus threshold for taxable years beginning on or after January 1, 2020 of $500,000. Texas adopted a $500,000 economic nexus threshold for its franchise tax reports due on or after May 2020.
Income Tax – Sourcing of Receipts from Services/Intangibles
A majority of states now source receipts from services and intangibles based upon market-based sourcing, i.e., where the benefit of the service is received. Thus, if a business has customers or investors in other states, the benefit may be received (and returns must be filed/taxes paid) in those other states. North Carolina adopted market-based sourcing applicable to the 2020 tax year. Key again is where the customer is located and received the benefit and not where the business is located.
CARES Act Conformity
The federal CARES Act provided tax relief at the federal level to businesses, however, the states have been slow to adopt conformity to the Act given the substantial costs of such conformity. Virginia currently conforms to the Internal Revenue Code in effective December 31, 2019, and thus does not conform to the CARES Act provisions. The General Assembly will need to enact legislation in its regular session beginning in January, however, given the potential costs to the state it is unclear if this will happen. Some other states, such as North Carolina and South Carolina, have already conformed to some but not all CARES Act provisions. CARES conformity will be a compliance complicator for 2020 returns.
COVID-19 Remote Work Tax Considerations
Remote Work and Nexus
The COVID-19 pandemic has resulted in employees continuing to work remotely much longer than originally anticipated. Some states have specifically addressed the possible sales/use tax and income/franchise tax nexus due to this, with most indicating that having employees working remotely due to solely COVID-19 will not create nexus provided the remote work is done in the state of emergency period or other predetermined period. Some states have been silent on the issue, suggesting the possibility they may assert nexus due to remote workers. Businesses need to closely monitor where their employees are working to accurately determine their nexus and tax filing requirements.
Remote Work and Withholding Requirements
Even though some states have announced they will not require withholding if employees are working remotely from where they normally do not work, businesses need to watch the days spend in the states as some states (e.g., New Jersey) have said that if employees are working more than 183 days in the state due to COVID, they are considered actual residents, and subject to income tax filing and payment requirements.
We expect (hope) additional guidance from the states will be forthcoming in the near-term.
Ohio, Tennessee, California, Washington, and other states have bright line economic nexus thresholds for their franchise taxes and regardless of what product or service a business is selling or providing, it may be subject to such taxes if the gross receipts from in-state customers reach the states’ thresholds. Beginning January 1, 2020, Washington State lowered the threshold for its business and occupation tax to $100,000 in sales into the state. Other states with franchise taxes may not have the bright-line thresholds but rather require businesses that are “deriving receipts from in-state customers” to file/pay thus once again knowing where one’s customers are located is key to state tax compliance. The federal protections against income tax filing requirements as noted above do not apply to franchise taxes.
Abandoned and Unclaimed Property (AUP)
Many businesses are not aware of their requirements to report AUP which includes uncashed payroll checks, vendor checks, account credit balances, gift cards, etc., to the states after the property has been dormant for a specified period (typically 5 years). This affects all types of businesses, including professional services firms, doctors, retailers, wholesalers, manufacturers, nonprofits, and others. The penalties for noncompliance are stiff. Unclaimed property is generally reportable to the state of the last known address of the “owner” of the property or if that is unknown, to the state of corporate domicile.
Business, Professional and Occupational License (BPOL) Tax
Many Virginia localities impose a business license (BPOL) tax for the privilege of doing business in the locality. BPOL generally is due even if a business is in a loss situation as the tax is assessed on gross receipts. It is important to ensure proper classification by and reporting to a locality in order to avoid possible overpayments of BPOL. In addition, if a business has been required to close or move from a locality during the year, it generally is entitled to a refund of BPOL (prorated) but must actively seek the refund by submitting the proper forms or contacting the locality directly. Further, some localities, such as the City of Richmond, offer BPOL incentives to attract new businesses but these incentives must be sought prior to beginning operations. Business licenses and other local taxes may be required by other states to the extent a business has operations (office, employees) in the other states.
Business Tangible Personal Property v. Machinery and Tools Tax
Manufacturing businesses are subject to the Machinery and Tools Tax (M&T) tax on equipment used in manufacturing but do not owe business personal property tax on furniture, fixtures, or computers used in administrative functions. Manufacturing businesses should ensure they are not incorrectly reporting or over-reporting to localities.
Machinery and tools and business tangible personal property are reportable to a locality if owned on January 1. For businesses needing to downsize operations due to remote workforces, disposing of physical assets prior to January 1 will result in property tax savings. Such disposals, however, should be well-documented. Idle equipment/furniture generally is taxable unless strict requirements are met. It is noteworthy that business personal property taxes, unlike BPOL, are not refundable.
All Virginia businesses should be paying sales/use tax on their purchases of tangible personal property for their own use, unless a specific exemption (i.e., resale, manufacturing, nontaxable item/service) applies. If taxable purchases are made from an out-of-state seller that does not collect Virginia use tax, the business is required by law to self-assess and report use tax directly to the Department of Taxation. Now that Virginia requires marketplace facilitators (Amazon, etc.) to collect the tax on behalf of third party sellers through their marketplace this issue may not arise as frequently as it used to but businesses still need to be attentive to the issue by reviewing purchases invoices, etc.
Contemplating a Business Exit or Sale?
Business owners contemplating an exit or sale of their business in the next 3 to 5 years should consider a top-level review of the potential state and local tax exposure. In working with our business clients, we often find that state and local tax liabilities discovered through due diligence are deal-breakers or may result in a substantial reduction in the sales price. It is a best practice to invest time in planning and pre-deal clean up versus waiting until later when the clean-up is much more involved and costly.
State and local tax compliance is becoming increasingly complicated. Questions on state and local tax concerns specific to your business? We can help. Contact your Opportunity Advisor or Email | Call: 804.747.0000
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About the Author
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.